The economics and politics of instability, empire, and energy, with a focus on Latin America and the Caribbean, plus other random blather and my wonderful wonderful wife. And I’d like a cigar right now.

April 11, 2017

Puerto Rico is still a pretty nice place

A long time ago, I had a debate with my friend (and sometimes co-blogger) Doug Muir about Puerto Rico. Was it really that much better off as a territory of the United States? He mentioned that Costa Rica was not all that bad off. I said, yes, true ... but the place is not in the same league as Puerto Rico.

Even if you use a generous purchasing power parity adjustment for Costa Rica, the place is still dreadfully poor compared to Puerto Rico. The OECD uses a PPP exchange rate of 370 colones per dollar: at that rate, the middle quintile in Costa Rica earns between $5,202 and $8,581 per year. (Note that while costs in Puerto Rico are not much less than on the mainland, they are less than on the mainland. But people who tell you otherwise are not crazy: milk and vegetables are far more expensive for reasons which I do not understand while electricity is far pricier for reasons that I understand full well. Those three items are highly visible and can easily make the island feel more expensive the mainland.)

And Puerto Rico lacks the kind of horrible rural poverty that you can easily find in Costa Rica.

In short, Puerto Rico is facing an economic crisis of biblical proportions. It has a very difficult decade ahead of it. Puerto Ricans have a lot to dislike about the institutions that link the island to the rest of the United States. But the residents of that island are still far better off than they would be had those links never existed.

Puerto Rico, while much poorer than the USA, has a similar standard of living to poorer countries in Western Europe like Portugal while Costa Rica has a standard of living more like an average Latin American country. However given rapid Tico growth and likely Puerto Rican stagnation totally possible to have catch-up by 2040 say.

Although I'd note that Portugal isn't really independent in the sense that Costa Rica is independent; it looks more like Puerto Rico than you might think. Net federal transfers have historically run around 8% of Puerto Rico's GDP; net European Union transfers to Portugal have run about 3%. So while not quite the United States, the E.U. has played a similar role in Portuguese development.

Obviously that doesn't mean that the ticos can't catch-up; other small countries have done so. Panama appears to be in the course of doing so, albeit with eye-popping inequality. I̶n̶ ̶2̶0̶1̶2̶,̶ ̶t̶h̶e̶ ̶m̶e̶d̶i̶a̶n̶ ̶h̶o̶u̶s̶e̶h̶o̶l̶d̶ ̶i̶n̶c̶o̶m̶e̶ ̶i̶n̶ ̶P̶a̶n̶a̶m̶a̶ ̶w̶a̶s̶ ̶$̶1̶3̶,̶7̶1̶6̶ ̶p̶e̶r̶ ̶y̶e̶a̶r̶,̶ ̶n̶o̶t̶ ̶t̶o̶o̶ ̶f̶a̶r̶ ̶o̶f̶f̶ ̶P̶u̶e̶r̶t̶o̶ ̶R̶i̶c̶o̶'̶s̶. Whoops -- apparently the Panamanians use "medio" to mean "promedio." The average income for the middle quintile (≈ median) was $9,138 in 2012. See page 13 here.

I would, however, be reluctant to predict that Puerto Rican stagnation will last until 2040. I'm reluctant to predict anything that far out! I would have been fine with such projections around 1990, but right now I'm not prepared to reject the hypothesis that automation and artificial intelligence is going to blow large and unpredictable holes in all our growth and convergence models over the next quarter-century. (I may just be future shocked, or the robots may indeed be about to destroy our social system.)

-- If you don't want to read the whole thing, teal deer: PR's population peaked in the years 1996-2010 at around 3.7 to 3.8 million. It has fallen fast since then, with the current population being around 3.4 million: around a 10% loss over a decade. That looks more like Eastern Europe than anything the Caribbean has ever seen before.

Based on reasonable projections, it should continue to fall for some time to come. An optimistic projection would be around 3.2 million in 2040, and a pessimistic projection would be more like 2.4 million. (The main driver is of course emigration, and emigration that's disproportionately by young people in their peak fertility years. However, low rates of immigration, falling TFRs, and stagnant or rising death rates are all playing a part.)

The crisis going on for a generation doesn't actually seem insane to me, absent some bold action on someone's part.

The discussion was in one of the old email threads: you pointed out that the GDPC of both places was similar. The discussion was really about Guam, which is waaaaay more prosperous than it would be outside the United States. (Or, likely, inside anywhere else.)

The generational crisis possibility sounds plausible. Still, let's run with Portugal. It seems to pulling out without any debt write-downs, which P.R. still seems likely to get. Why would we expect P.R. to follow Greece rather than Portugal? Portugal, after all, had a recent emigration history than Greece lacked. (Relatively.)

Since Doug brought this up, I now notice that PR held yet another referendum but this time the turnout was shockingly low. Just 23%. When normally for referenda they get over 50% (and I think for status referenda they normally get 70% turnout). Could the high emigration be a reason (but clearly not the only reason) for this large drop in turnout in just 4-5 years?

Doug, keep in mind that things that cannot continue, don't. The Commonwealth government has already announced that it will repudiate its debts to the Government Development Bank. The GDB, in turn, is going to impose haircuts between 25% and 45% on its creditors.

The only part of the debt that can't be restructured are the general obligation bonds. But that's only $13bn of the $64 to $80 bn that the island owes.* Of the remaining $51b-$67b, that's going to be cut by at least a third. Maybe more.

Also note that inflation helps. Even in the case of zero per capita economic growth and 10% decline in the labor force, 2% inflation will cause nominal GDP to grow 10% over the next decade.

Population loss is a problem. But it's a second-order problem.

N

* The courts might interpret Article 6, Section 8 of the Puerto Rican constitution to include more debt issues.

I would disagree that it's a second-order problem. They've had 10% population loss *already*. They're definitely going to lose more. The only question is how much.

The pessimistic projection has them at ~2.4 million in 2040, which would represent a population loss of over a third from the 1996-2010 peak. There's literally no equivalent to that in the developed world in the last hundred years. Some of the more awful parts of Eastern Europe, mmmaybe?

The optimistic scenario has them dropping down to around 3.1 million in the 2020s then beginning a slow rebound in the 2030s. That means nominal GDP will be, at best, stagnant over the next decade or so.

Nominal GDP in Puerto Rico has grown every year since 2007. Last year GDP grew 1.8%. Domestic tax revenue rose 3.4%, admittedly due to draconian tax hikes.

All this in the face of a population fall of 1.8%, a drop in the civilian labor force of 1.0% and a fall in employment of 0.8%. The population fall obviously does not help, but it certainly seems to be a second-order problem because inflation.

So if you don't mind, how did you calculate that nominal GDP will stagnate over the next decade?

One very common mistake is to forget that nominal GDP growth is what matters for debt repayment. After all, the debt isn't linked to real growth.

As long as nominal GDP is growing, the debt burden will start to fall once the budget is balanced.

Right now, the Commonwealth government plans to stop the growth in the debt burden through a combination of tax hikes, spending cuts, and debt structuring. The projections assume nominal GDP shrinkage through 2021, which is unlikely. (Page 11 at the below link.)

Obviously, a fall in the working-age labor force isn't helpful, but it's a second-order problem. A growing population (everything else equal) wouldn't make Puerto Rico's fiscal challenges significantly easier. An acceleration of inflation by about 0.8% would have the same effect.